The paper empirically examines the impacts of federal transfers on State tax efforts and expenditure taking into consideration a panel data set of 22 Indian States for the time-period 1980-81 to 2007-08. Dynamic panel equations are specified and system GMM estimation techniques are adopted to obtain the regression coefficients. The results suggest that federal transfers have adverse incentives on budgetary initiatives of States in mobilizing their own tax resources and regulating expenditure. Federal transfers as a whole adversely affect states Tax-GSDP ratio and per capita own tax revenues. Similarly, federal transfers have important influence on the size and pattern of States spending. All categories of States expenditure like revenue expenditure, capital disbursements and aggregate expenditure are stimulated by the large availability of Central transfers. Expenditure impact of transfers is more realised on revenue expenditure than capital disbursements. The author calls for review of existing design of transfers and criteria, proper assessment of non-plan revenue deficit grants, review of ratio of specific transfers to lump-sum transfers and increasing the scope of formula based transfers to handle adverse budgetary incentives of federal transfers.
Budgetary Impacts of Central Fiscal Transfers in India: Evidence from State Level Data